Federal Reserve Bank of Dallas President Richard Fisher finally has gone where Congress and the Obama administration have feared to tread. He’s called for an international pact to break up banks that pose a systemic risk to the world’s economy. And if other nations won’t do it, the United States should go it alone.
Senators have become hung up over the shape and location of a Financial Consumer Protection Agency and whether to create a “resolution fund” with new fees and taxes on financial institutions and their investors and depositors.
They are missing the point of the recent financial meltdown. If a financial institution is considered too big to fail, it is too risky to allow it to exist.
It is really just that simple.
As Federal Reserve Governor Kevin Walsh recently noted, market discipline only works when insolvent firms meet their demise. If regulators fear allowing institutions to go under, moral hazard increases the likelihood of excessive risk taking, exacerbating the financial problems that will follow.
The financial meltdown of 2008 and its aftermath are examples of what happens when government undermines market discipline by implicitly guaranteeing life support for firms considered “too big to fail.”
A new agency to protect consumers and a new slush fund for bailouts do worse than just paper over this problem. They give a false sense of security that everyone is protected.
And as the debate over them rages, the problem gets worse. Big banks are seeking to become even bigger. Thus, JP Morgan Chase has announced a plan to pay $1.7 billion for Sempra Energy’s European and Asian commodity trading units.
To illustrate the point with a twist from Martin Luther King Jr.: “The long arch of capitalism bends toward size.”
It is large transactions that have led to the share of the financial industry’s assets held by the 10 largest U.S. banks to increase from 25 percent in 1990 to 60 percent last year. Put another way, of the $12 trillion in bank assets in the United States, each of the top 10 banks controls $720 billion, while the roughly 8,000 other banks — mostly community banks — each controls on average $600 million.
The financial system deals with community bank failures expeditiously in a way well understood by their regulators, depositors and investors — when they fail, they fail. Local communities may take a hit, but the national economy isn’t threatened.
The misguided lesson learned by experts and Congress from this policy failure has been to try to solidify big banks’ balance sheets and/or have a resolution authority ready to prevent market panics in case excessive risk-taking leads to another failure.
The administration’s proposed “Volcker Rule,” named after former Fed Chairman Paul Volcker, would bar banks from trading for their own benefit with FDIC insured deposits.
But that doesn’t solve the problem of a run on banks if a big interconnected financial institution begins to fail. In the financial crisis, when AIG blew up, the Fed had to extend insurance to non-FDIC insured money-market deposits to prevent a run and capital collapse.
Meanwhile, the suggestion by Republican Sen. Bob Corker of Tennessee to create an FDIC-like resolution agency for failed banks amounts to an insurance policy for too big to fail.
It would tax all banks, even those that don’t pose a systemic risk, and hence their small investors, retirees and ultimately taxpayers. And for what? The $17 billion the proposal would set aside wouldn’t cover a 30th of the assets of one of the largest institutions.
Too-big-to-fail also is just too expensive to insure.
As Fisher points out, the vital need is that such systemically hazardous firms be made smaller. That’s the only way to distribute risks and ensure market safety.
Making big banks smaller can promote protection for depositors and investors along with the economy. The majority of company 401(k)s, pensions, or trusts are funneled through large investment strategists such as Vanguard, Janus, or John Hancock, which in turn place their investments with America’s largest investment banks.
If the banks became smaller, robust competition would lead those massive pools of retirement capital to be dispersed throughout the whole financial system, rather than sitting with a few large, systemically risky banks.
Downsizing the big banks thus would lead to diversification, the best protection any investor can have.
And by making all executives and directors personally liable for abuse in financial reporting, deception or excessive risk-taking with insured deposits, institutions then would provide more transparent information for investors about asset quality and funding sources.
But the first step is to deal with the problem of institutions that are too big to fail. And that means breaking them up so they aren’t too big to fail.
Sam Zamarripa is chairman and co-founder of Stop Too Big to Fail, a former Georgia state senator and president of Zamarripa Capital, a private equity corporation focused on lower middle market companies in the southeastern United States.
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